The Bank of England has unveiled a new stress test for Britain’s banks and says it will assess lenders' plans for Brexit, as Prime Minister Theresa May prepares to start the process officially on Wednesday.
In a statement following the latest meeting of the Financial Policy Committee (FPC), the Bank said: “The FPC will assess the financial stability implications of firms’ plans to adapt to the United Kingdom’s withdrawal from the European Union.”
This will run alongside a new "exploratory stress test" which will see what will happen if banks continue to face challenges to their business models on multiple fronts.
The test, with a seven-year horizon, will "incorporate weak global growth, persistently low interest rates, falling world trade and cross-border banking activity, increased competitive pressure on large UK banks from smaller banks and non-banks and a continuation of costs related to misconduct," the FPC said.
Meanwhile the Bank's standard stress tests of British lenders, with results due in November, will look at how banks will respond to the triple shock of a big recession in the UK, higher interest rates and a 33 per cent fall in house prices.
Royal Bank of Scotland failed the last stress test in November, with Barclays and Standard Chartered both failing on one of the measures. The other three banks plus Nationwide passed the tests.
The Prudential Regulation Authority (PRA) will also review the rise of consumer credit to judge if banks are taking on riskier loans. The PRA is separate to the FPC but is run by the Bank of England.
"UK household indebtedness remains high by historical standards and has begun to rise relative to incomes," the FPC's statement said.
Stability after Brexit
The FPC, which is tasked with looking after the UK’s financial system, said banks should work to avoid disruption of cross-border operations, which could harm the EU economy.
The FPC said: “Sudden adjustment could disrupt the provision of market liquidity and investment banking services, particularly to the EU real economy, which could spill back to the UK economy through trade and financial linkages.”
The Bank also said it saw the possibility of firms using more complex business structures after Brexit which could “reduce the resilience” of British financial services. The Bank is “examining appropriate mitigants”, it said.
Brexit had previously been judged as one of the biggest risks to the UK's financial stability by the Bank. The FPC previously said the vote's result was one of the biggest risks to financial stability.
However, the view of the Bank has gradually evolved as the UK economy has seen little effect since the Brexit vote. The Bank of England downgraded its own assessment of immediate Brexit risks, while revising up its forecasts for UK growth.
While the the FPC said the risk outlook to the global financial system was “broadly unchanged”, it noted “policy uncertainty is high across a range of advanced economies.”
Massive levels of borrowing in the Chinese economy and the overhang of government debt in some of the Eurozone’s more vulnerable economies pose the biggest risks to the financial system.
The Bank also pointed to the growing backlash against international trade and integration of the global financial system as a major risk.
“In the global economy, although near-term prospects have improved, risks remain elevated.”
These risks are not fully reflected in asset prices, which remain high, or volatility, which remains low, the FPC said.